Commissioner Of Income-Tax v. Arkay Wires P. Ltd.

R.K Agrawal, J.:— The Income-tax Appellate Tribunal, Allahabad, has referred the following two questions of law under section 256(1) of the Income-tax Act, 1961, hereinafter referred to as “the Act”, for opinion to this court:

“1. Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal was legally justified in its opinion that the firms, M/s. Techno Sales Corporation and M/s. Kumar Wire and Conductors were not sole selling agents of the company and, therefore, the provisions of section 294(2) were not attracted?

2. Whether, on the facts and circumstances of the case, the Tribunal was legally correct in holding that the provisions of section 314(1)(b) of the Companies Act, 1956, were not applicable?”

2. Briefly stated the facts giving rise to the present reference are as follows: The assessment year involved is 1973-74. The respondent-assessee is a private limited company, hereinafter referred to as the company. Its previous year for the assessment year 1973-74 commenced on July 1, 1971, and ended on June 30, 1972. It paid selling agency commission to its selling agents as follows:

1. M/s. Techno Sales Corporation Rs. 1,02,361

2. M/s. Kumar Wires and Conductors Rs. 16,992

3. The company has been manufacturing galvanised iron wire, mild steel wire on barbed wire from the previous year corresponding to the assessment year 1968-69. On August 9, 1968, it entered into a selling agency agreement with a firm styled as M/s. Techno Sales Corporation, Swarup Nagar, Kanpur, whereby the said firm got the selling agency right for the sale of mild steel wires, galvanised wires and other wire products manufactured by the company for the State of Uttar Pradesh. The said firm was to canvass and secure orders for the products manufactured by the company to the best of its ability and experience and for rendering these services, the firm was to be paid a commission of 1 per cent, on all sales effected by the company of the goods manufactured by them either to market parties or to the Government departments. This agreement was to remain in force for a period of five years from August 9, 1968, and during this period the firm was not to canvass for or act as selling agent for goods of the same kind for any other manufacturer. During the accounting period under consideration, i.e, July 1, 1971 to June 30, 1972, the constitution of the selling agency firm was as follows:

1. Shri Santosh Kumar s/o Shri Kishan Sarraf 15% 2. Smt. Harmukhi Devi w/o Shri Kishan Sarraf 15% 3. Shri Sudershan Kumar s/o Shri R.K Agarwal 15% 4. Smt. Shushila Sarraf w/o Shri Vijay Kumar 15% 5. Smt. Shashikanta Bansal w/o Shri M.C Bansal 10% 6. Master Jitender Mohan s/o Shri H.K Sarraf 15%

4. Many of the partners in the aforesaid firm were related to the directors of the respondent as is clear from the following list of the directors during the relevant previous year:

1. Shri R.K Agarwal s/o Shri Mohan Lal

2. Shri H.K Sarraf s/o Shri Kishan Sarraf

3. Smt. Sushila Devi w/o Shri R.K Agarwal

4. Shri M.C Bansal s/o Shri Pritam Chand.

5. It appears that the selling agency agreement was not put up by the company before the general meeting of its shareholders, which was held immediately after the execution of the said agreement or even thereafter till the Income-tax Officer completed the assessment for the year under consideration. It was put up before the general body meeting only thereafter on June 28, 1975, when a resolution was passed confirming the appointment of M/s. Techno Sales Corporation as the selling agency of the respondent-company. However, the proposal of the appointment of the aforesaid firm as selling agent was passed in the meeting of the board of directors of the company held on January 10, 1969. It may be mentioned here that the payment of commission of the aforesaid selling agency, namely, M/s. Techno Sales Corporation, by the company in the previous years corresponding to the assessment years 1970-71, 1971-72 and 1972-73 was not objected to by the Income-tax Officer during the course of the said assessment proceeding. However, he raised objection to the payment of commission in the course of assessment proceedings under consideration. During the previous year relevant to the assessment year in question, the company also started manufacturing aluminium conductors styled AAC and ACSR. For promoting the sales of the aforesaid goods, it appointed M/s. Kumar Wires and Conductors as its selling agent for the State of Uttar Pradesh on April 1, 1972, pursuant to an agreement. For the services rendered by the said agent, the company was to pay a commission at the rate of 1 per cent, on all sales of aluminium conductors either to market parties or to the Government departments. Even this selling agency agreement was not put up by the company for the approval of its first annual general body meeting held immediately after the execution of the said contract or even thereafter till the assessment for the year was completed by the Income-tax Officer. It was placed before the general body meeting for its approval in its meeting held on June 28, 1975. The board of directors had, however, confirmed the appointment of the said agency vide resolution dated January 25, 1972. The following persons were the partners of M/s. Kumar Wires and Conductors:

1. Shri H.K Sarraf

2. Smt. Sushila Devi Agarwal

3. Shri Vijai Kumar

4. Saroj

5. Shri Sudershan Kumar

6. Smt. Harmukhi Devi

6. It may be mentioned here that M/s. Techno Sales Corporation were doing business of selling agents not only for the company but others also. In fact, they had been doing business since the assessment year 1965-66 onwards for almost three years prior to their agreement with the company. From the various documents and correspondence placed on record by the respondent-company, it transpired that M/s. Techno Sales Corporation were attending to opening of tenders on behalf of the company, obtaining the statements of prices, terms and conditions of various tenders, etc., and furnishing such information to the company. They were also following up the collection for and on behalf of the company from the various Government departments. The firm of Kumar Wires and Conductors, Kanpur, apart from the commission received from the company, had income from wire standing operations, which it was doing for and on behalf of the company. During the course of the assessment proceedings, the Income-tax Officer examined the question of the deducibility of the selling agency commission while computing the total income of the company and came to the conclusion that the payments in question could not be allowed as legitimate business deductions for the following reasons:

1. That the selling agency firms did not render any services to the assessee-company to justify the aforesaid payments.

2. That the agreement with M/s. Techno Sales Corporation was a sole selling agency agreement and inasmuch as this agreement was not ratified in the first annual general body meeting of the company held after the execution of the said contract, it was void ab initio in terms of sub-section (2) of section 294 of the Companies Act, 1956.

3. That the agreement was also hit by the provisions of section 314(1)(b) of the Companies Act, and,

4. That, therefore, the payments to the selling agents were not allowable as business expenditure under section 37 of the Income-tax Act, 1961.

7. The company feeling aggrieved, preferred an appeal before the Appellate Assistant Commissioner, who after examining the evidence on record, gave the finding that the selling agency firms were rendering services to the respondent-company but nevertheless he held that the payments in question were not allowable deductions because the said selling agents were, in fact, sole selling agents and inasmuch as the agreement entered into with them were violative of the provisions of sub-section (2) of section 294 and sub-section (1)(b) of section 314 of the Companies Act, 1956, the payments made to them could not be allowed as legitimate business expenditure under section 37 of the Act.

8. Feeling aggrieved by the said order, the Revenue as well as the assessee preferred separate appeals before the Tribunal. Before the Tribunal, the two members differed in their opinion and, therefore, the matter was referred to the third member, who after going to the various clauses of the agreement, had held that the selling agency agreement in question was not a sole selling agency agreement. According to the third member, the provisions of sub-section (2) of section 294 of the Companies Act had not been violated by the company and they were also not violative of section 314 of the Companies Act, 1956. Apart from the fact that the third member had held that the agreement in question was not a sole selling agency agreement nor was it violative of section 314 of the Companies Act, he was of the opinion, that if the agreements were held to be sole selling agency agreements they would be void and of no effect following the decision of the Bombay High Court in the case of Arantee Manufacturing Corporation v. Bright Bolts (P) Ltd., [1967] 37 Comp Cas 758; [1967] 2 Comp LJ 54. The Tribunal in conformity with the opinion expressed by the third member allowed the appeal filed by the respondent.

9. We have heard Sri Dhananjay Awasthi, learned standing counsel appearing for the Revenue, and Sri S. Chatterjee, learned counsel for the company.

10. Learned counsel for the Revenue submitted that the agreements in question are sole selling agency agreements and reiterated the submissions made by the Department before the Tribunal, which are in the following terms:

“1. That, mention of the phrase, ‘sole selling agent’ in the agreement of selling agency was not necessary to determine as to whether or not a selling agent was a sole selling agent; all the facts and attendant circumstances had to be looked into for determining the true nature of the selling agent.

2. That M/s. Techno Sales Corporation received commission with regard to all the sales of steel wire products in the State of Uttar Pradesh and that went to show that they were sole selling agents. Similarly, Kumar Wires and Conductors were sole selling agents of the assessee in Uttar Pradesh with regard to aluminium conductors.

3. That it was wrong to say that the sole selling agency agreement had to be exclusive only with reference to territory; it could be with reference to the different types of products also giving exclusive rights to sell the specified products in a given territory.

4. That the products marketed through M/s. Techno Sales Corporation and M/s. Kumar Wires and Conductors were not similar; they were altogether different products; one of steel wire simplidter, the other being aluminium conductors. They were not only made of different metal; their use and nature were also different.

5. That the selling agency agreements were covered by the extended definition of ‘office or place of profit’ as given in sub-section (3) of section 314 of the Companies Act. In support of the above proposition, reliance was placed on the following observations at page 577 of Second Edition of Dutta's Company Law:

‘The appointment of managing director or a director of company or his relative as sole selling agent is to be regarded as office of profit under the company within the meaning of section 314 of the Act and requires a special resolution according to the consent of the company for such appointment.’

6. That, in view of the above position, M/s. Techno Sales Corporation and M/s: Kumar Wires and Conductors have to be deemed to have vacated their offices of sole selling agents under section 314 on the dates next to the date of the first general meeting held after the dates of the respective agreements as their appointments were not approved therein, and that later ratification of the agreements by the general body meeting on June 28, 1975, was of no avail for, what was void ab initio could not be validated by a subsequent act of ratification.

7. That, for determining the total income of the company, the Income-tax Officer could enquire whether certain payments contravened the provisions of the Companies Act and whether or not they were expenses, in fact, incurred by the company and whether the same were incurred as a trader or otherwise, and while doing so, the Income-tax Officer was not bound to consult the Registrar, Joint Stock Companies, or any other authority under the Companies Act, for it was the sole prerogative of the Income-tax Officer to determine the assessee's total income.”

11. In support of his submissions, he relied upon the following decisions:

(1) Godavari Sugar Mills Ltd. v. CTT, [1963] 49 ITR 206 (Bom);

(2) Arantee Mfg. Corporation v. Bright Bolts P. Ltd., [1967] 37 Comp Cas 758 (Bom); AIR 1967 Bom 440;

(3) Nawabganj Sugar Mills Co. Ltd. v. CTT, [1972] 86 ITR 44 (SC); and

(4) Lachminarayan Madan Lal v. CTT, [1972] 86 ITR 439 (SC).

12. Sri S. Chatterjee, learned counsel for the respondent, however sub-12 mitted as follows:

1. That M/s. Techno Sales Corporation and M/s. Kumar Wires and Conductors were not sole selling agents of the company and that, therefore, the provisions of sub-section (2) of section 294 and of sub-section (1)(b) of section 314 of the Companies Act did not apply to the contracts entered into by the company with them.

2. That the agreements entered into with the said parties were bona fide and were made in the interest of business and, therefore, the payments in question were allowable under section 37 of the Act, as having been laid out or expended wholly and exclusively for the purpose of the assessee's business.

3. That, while determining the total income of the company, the Income-tax Officer could not travel beyond the terms of the Act and that, if he came to the conclusion that the services were, in fact, rendered, the expenditure will have to be allowed to the assessee as a legitimate business deduction in terms of section 37 of the Act.

4. That the general body of the shareholders had passed a special resolution on June 28, 1975, ratifying the aforesaid two agreements right from the very beginning and, therefore, whatever lacuna, if any, was there, had been made good and there could be no justification to uphold the disallowance of the commission paid by the Income-tax Officer merely on the ground that the agreements in question had not been ratified by the general body meeting earlier.

5. That, section 314 of the Companies Act, 1956, did not cover the case of a selling agent who did not derive a monthly remuneration nor did it hold any office or place of profit under the company. Reference was made to a circular issued by the Company Law Board. In view of the above instructions of the Company Law Board, it was urged that it would be wrong to apply section 314 to the selling agency agreements.

6. That the Income-tax Officer could not exercise any powers under the Companies Act, 1956, and, therefore, could not hold that the company had violated any of the provisions of the Companies Act. This could be done only by the Company Law Board under section IOC of the Companies Act or by the competent courts under section 10 of the said Act.

7. That the principle of quantum meruit worked against the company and it could not recover the payments made to the selling agents even if it was held that the said contracts were invalid for it had accepted the services rendered by the agents and had made payments therefor.

13. Having heard learned counsel for the parties, we find that in the agreement entered into by the company with M/s. Techno Sales Corporation on August 9, 1968, M/s. Techno Sales Corporation has been appointed as its selling agent for the sale of mild steel wire, galvanised iron wire and other wire products in the State of Uttar Pradesh. One of the terms and conditions of the agreement was that the said agency shall be paid by the company a commission of 1 per cent, on all sales effected by the company of the goods manufactured by them either to market parties or to the Government department. The relevant clauses (1) and (5) of the said agreement are reproduced below:

“(1) The principal hereby appoints the agent to be its selling agent for the sale of mild steel wires, galvanised wires and other wire products manufactured by the principal, for the State of Uttar Pradesh and the agent hereby agrees to act as such selling agent on the terms and conditions mentioned herein.

(5) The agent shall be paid by the principal a commission of 1 per cent, on all sales effected by the principals of the goods manufactured by them, either to market parties or to Government departments.”

14. In respect of the agreement entered into by the company with M/s. Kumar Wires and Conductors on March 21, 1972, the terms and conditions except product difference are the same. Clauses (1) and (5) of the said agreement are reproduced below:

“(1) The principal hereby appoints the agent to be selling agent for the sale of AAC, ACSR conductors and other aluminium conductors manufactured by the principal and the agent hereby agrees to act as such selling agent on the terms and conditions mentioned herein.

(5) The agents shall be paid by the principal a commission of 1 per cent, on all sales effected by the principals of the goods viz., AAC, ACSR and other conductors manufactured by them, either to market parties or to Government departments. The said commission shall be payable at the end of each accounting year of the principal.”

15. From the reading of the aforesaid clauses of the two agreements, we are of the considered opinion that the two parties have been appointed as their selling agents to the exclusion of others in respect of different products manufactured by the company for the entire State of Uttar Pradesh and the said agents were entitled for payment of commission at the rate of 1 per cent, of sales of all such products within the State of Uttar Pradesh either effected by the agents or by the company.

16. Section 294 of the Companies Act, 1956, prohibits the appointment of sole selling agent for any area for a term exceeding five years at a time. Sub-section (2) provides that the appointment of the sole selling agents for any area shall cease to be valid if it is not approved by the company in its first general meeting held after the date on which the appointment is made. Section 294 of the Companies Act, 1956, in so far as it is relevant for the purposes of the present reference is reproduced below:

“294. Appointment of sole selling agents to require approval of company in general meeting.—(1) No company shall, after the commencement of the Companies (Amendment) Act, 1960, appoint a sole selling agent for any area for a term exceeding five years at a time:

Provided that nothing in this sub-section shall be deemed to prohibit the reappointment, or the extension of the term of office, of any sole selling agent by further periods not exceeding five years on each occasion.

(2) After the commencement of the Companies (Amendment) Act, 1960, the board of directors of a company shall not appoint a sole spiling agent for any area except subject to the condition that the appointment shall cease to be valid if it is not approved by the company in the first general meeting held after the date on which the appointment is made.

(2A) If the company in general meeting as aforesaid disapproves the appointment, it shall cease to be valid with effect from the date of that general meeting.”

17. section 314 of the Companies Act, 1956, provides that except with the consent of the company accorded by a special resolution, a director shall not hold any office or place of profit. Section 314(1) of the Companies Act, 1956, is reproduced below for ready reference:

“314. Director, etc. not to hold office or place of profit.—(1) Except with the consent of the company accorded by a special resolution,—

(a) no director of a company shall hold any office or place of profit, and

(b) no partner, or relative of such director, no firm in which such director, or a relative of such director, is a partner, no private company of which such director is a director or member, and no director, or manager of such a private company, shall hold any office or place of profit carrying a total monthly remuneration of such sum as may be prescribed,

except that of managing director or manager, banker or trustee for the holders of debentures of the company,—

(i) under the company; or

(ii) under any subsidiary of the company, unless the remuneration received from such subsidiary in respect of such office or place of profit is paid over to the company or its holding company:

Provided that it shall be sufficient if the special resolution according the consent of the company is passed at the general meeting of the company held for the first time after the holding of such office or place of profit:

Provided further that where a relative of a director or a firm in which such relative is a partner, is appointed to an office or place of profit under the company or a subsidiary thereof without the knowledge of the director, the consent of the company may be obtained either in the general meeting aforesaid or within three months from the date of the appointment, whichever is later.

Explanation.—For the purpose of this sub-section, a special resolution according consent shall be necessary for every appointment in the first instance to an office or place of profit and to every subsequent appointment to such office or place of profit on a higher remuneration not covered by the special resolution, except where an appointment on a time-scale has already been approved by the special resolution.”

18. From a conjoint reading of the provisions of sections 294 and 314 of the Companies Act, 1956, it will be seen that a company cannot appoint a sole selling agent for any area for a term exceeding five years at a time and the agreement for appointment of sole selling agent has to be got ratified/approved by the company in its first general meeting held after the date on which the appointment is made failing which it shall cease to be valid with the date of first general meeting and further a director or any of his relative where such director or the relative is a partner in the firm cannot hold any office or place of profit except with the consent of the company accorded by a special resolution. The phrase “sole selling agent” has not been defined under the Companies Act, 1956. In common parlance and in ordinary sense, it would mean that the exclusive and sole right to sell all the products of the principal to the exclusion of all others. In the present case, two things under the separate agreements have been described as selling agents and not sole selling agents. Further, they have not been given exclusive right to sell all the products. Specific mention of the words “for any area” and omission to mention “any goods” makes it abundantly clear that there can be only one sole selling agent in an area in respect of all the goods dealt with by the company. It may be mentioned here that under sub-section (6) of Section 294 of the Companies Act, 1956, the Central Government has been empowered to call for information from the company where there are more than one selling agents in a particular area and to declare any one of them to be a sole selling agent of the company for such area or any of such areas. There is nothing on record to show or suggest that the Central Government had declared any one of the aforementioned selling agents as the sole selling agent of the company. Thus, they cannot be treated as sole selling agents.

19. In the case of Arantee Mfg. Corporation v. Bright Bolts P. Ltd., [1967] 37 Comp Cas 758, the Bombay High Court has held that sub-section (2) of section 294 should be interpreted to mean that it contains a condition precedent that attaches to the very act of making the appointment of a sole selling agent by the board of directors. Therefore, if any appointment of a sole selling agent is made by a board of directors without such a condition as mentioned in sub-section (2), the same would be contrary to the said provisions and would be void ab initio.

20. A similar view has been taken by the Calcutta High Court in the case of Shalagram Jhajharia v. National Co. Ltd., [1965] 35 Comp Cas 706 and the Kerala High Court in the case of Kerala Chlorates and Chemicals Ltd. v. Registrar of Companies, [1988] 63 Comp Cas 175. The contract in question appears to be grant of contract of appointment as distributor of the respondent's products and, therefore, it need not be placed before the company in general meeting. The Delhi High Court in the case of Globe Motors Ltd. v. Mehta Teja Singh and Co. (Agencies), [1984] 55 Comp Cas 445 has held that a distributor's contract is not a contract for appointment of a sole selling agent and thus it is not required to be placed before the company in general meeting.

21. As we have come to the conclusion that under the two agreements M/s. Techno Sales Corporation as well as M/s. Kumar Wires and Conductors have not been appointed sole selling agents and were only distributors/selling agents in respect of the specified goods, their appointment does not come within the purview of section 294(2) of the Companies Act, 1956. Even otherwise, as held by the Bombay High Court in the case of Arantee Mfg. Corporation v. Bright Bolts P. Ltd., [1967] 37 Comp Cas 758, as the agreement in question did not contain a clause that the agreement shall cease to be valid if it is not approved by the company in general meeting held after the date on which the appointment is made, it is void ab initio.

22. The words “office or place of profit” occurring in sub-section (1) of section 314 do include selling and buying agents receiving commission and/or salary. The sole selling agency has been held to be an office of profit by the Bombay High Court in the case of Firestone Tyre and Rubber Co. v. Synthetics and Chemicals Ltd., [1971] 41 Comp Cas 377. As in the present case, the two firms which have been appointed as the selling agents consist of either the directors or the relatives as their partners, a special resolution was required to be passed by the company for their appointment in the absence of which they would not have been appointed.

23. In the case of Godavari Sugar Mills Ltd., [1963] 49 ITR 206, the Bombay High Court has held that where the amount payable as dividends by the public companies was restricted by the Public Companies (Limitation of Dividends) Ordinance, 1948, the company was not able to declare the percentage of dividends as required by section 23A of the Indian Income-tax Act, 1922. The court has further held that if a restriction is imposed by any law on a company in respect of declaration of dividends at a particular point of time, then that restriction would equally be applicable to the Income-tax Officer, if by his order, he is creating a legal fiction of notional distribution of dividends at that particular point of time.

24. In the case of Nawabganj Sugar Mills Co. Ltd., [1972] 86 ITR 44, the apex court has held that the Appellate Tribunal has to act judicially in the sense that it has to consider with due care all material facts and evidence in favour of and against the assessee and record its finding on all the contentions raised by the assessee and the Commissioner in the light of the evidence and the relevant law.

25. In the case of Lachminarayan Madan Lal, [1972] 86 ITR 439, the apex court has held that the mere existence of an agreement between the assessee and its selling agents or payment of certain amounts as commission, assuming there was such payment, does not bind the Income-tax Officer to hold that the payment was made exclusively and wholly for the purpose of the assessee's business. Although there might be such an agreement in existence and the payments might have been made, it is still open to the Income-tax Officer to consider the relevant facts and determine for himself whether the commission said to have been paid to the selling agents or any part thereof is properly deductible under section 37 of the Act. The decisions relied upon by learned counsel for the Revenue are not applicable in the present case as the controversy raised in the present case is entirely different. As there is no dispute that some of the partners of the two firms are related to the directors of the company, the appointment of even selling agents amounts to holding an office of profit and is hit by section 314 of the Companies Act, 1956.

26. In view of the aforesaid discussion, we answer the first question referred to us in the affirmative, i.e, in favour of the assessee and against the Revenue, and the second question in the negative, i.e, in favour of the Revenue and against the assessee. However, there shall be no order as to costs.